The following discussion and analysis should be read in conjunction with "Selected Financial Data" and our consolidated financial statements and notes thereto included elsewhere in this annual report.

Overview

We design, develop, manufacture and commercialize a broad suite of IVUS and FM products. We believe that these products enhance the diagnosis and treatment of vascular heart disease by improving the efficiency and efficacy of existing PCI therapy procedures in the coronary or peripheral arteries. We market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.

Our IVUS products consist of ultrasound consoles, single-procedure disposable phased array and rotational IVUS imaging catheters and additional functionality options such as virtual histology, or VH, IVUS tissue characterization and ChromaFlo stent apposition analysis. Our IVUS consoles are marketed as stand-alone units or customized units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our IVUS consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure wires and Medtronic's Pioneer reentry device. We are developing additional offerings for integration into the platform, including, FLIVUS catheters, image-guided therapy catheters and ultra-high resolution OCT systems and catheters.

Our FM offerings include consoles and single-use pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure.

We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. We expanded our worldwide sales organization from 60 employees in July 2003 to 180 employees at December 31, 2008, which included 150 direct sales representatives in the United States, Western Europe and Asia. We sell our products directly to customers in certain European markets and utilize distributors in other European markets, including Spain, Portugal and parts of Italy. At December 31, 2008, our distribution efforts in Europe were led by a General Manager, a Director of European Sales, 16 account representatives and three clinical specialists. Three companies distribute our IVUS and FM products in Japan. We have direct contractual relationships with Goodman, Fukuda Denshi and Johnson & Johnson through which our IVUS and FM products are distributed in Japan. In addition, Fukuda Denshi has sub-distribution agreements with other parties. While these multi-level relationships allow us to access specific customers and markets, they create complex distribution arrangements and increase our reliance on our Japanese distributors. As of December 31, 2008, we support our Japanese

distributors through Volcano Japan which is led by a General Manager, two marketing, three distribution, and 16 sales and support staff. In emerging markets, including the major markets of Asia Pacific, Latin America, Europe, Australia, Africa and the Middle East, we have distributor relationships through which we sell our products. Our distributors are involved in product launch planning, education and training, physician support and clinical trial management.

Fukuda Denshi accounted for 14.2% of our revenues in 2006 and accounted for less than 10% of our revenues in 2007 and 2008. In the first quarter of 2005, Goodman, formerly Boston Scientific's distributor of its IVUS products in Japan, began to distribute our IVUS products in Japan through a sub-distribution agreement with Fukuda Denshi. Additionally, Fukuda Denshi transferred the Japanese regulatory approvals, or SHONINs, for our phased array IVUS products to us on June 1, 2006. Due to the transfer, we are now able to sell directly to distributors in Japan as opposed to being required to sell our phased array IVUS products only to Fukuda Denshi. As a result, for a portion of 2006, we sold directly to Goodman and Fukuda Denshi and the percentage of our revenues attributable to Fukuda Denshi declined, while the percentage of revenues attributed to Goodman increased, accounting for 14.4%, 18.0%, and 15.0% of our revenues for the years ended December 31, 2008, 2007 and 2006, respectively.

On May 19, 2008, we and Goodman, mutually terminated the Exclusive Distribution Agreement, dated September 27, 2004, pursuant to which Goodman distributed our IVUS products in Japan. Also on May 19, 2008, the oral agreement between us and Goodman, related to the exclusive distribution of our FM products in Japan, was terminated. We did not pay and we are not obligated to pay a termination fee in connection with this termination. On June 30, 2008, Goodman transferred to us all marketing authorization and other regulatory approvals, or SHONINs, for all specified products held by Goodman or its affiliates. Although Goodman currently continues to distribute our rotational IVUS and FM products in Japan on a non-exclusive, purchase order basis, there is no assurance that they will continue to do so in the future. Upon termination of our agreements with Goodman, we monitor the credit risk associated with Goodman as well as other general economic conditions and, accordingly, we have made and continue to make adjustments to the credit terms that are extended to Goodman.

We are also collaborating with GE for the development and distribution worldwide, except Japan, of our s5i GE Innova system, which is our IVUS imaging system console that is installed directly into a cath lab on a permanent basis and is able to be integrated with GE's Innova system.

At December 31, 2008, we had a worldwide installed base of over 3,200 IVUS consoles and over 800 FM consoles. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In 2008, the sale of our single-procedure disposable catheters and guide wires accounted for $125.4 million, or 73.1% of our revenues, a $27.6 million, or 28.2% increase from 2007, in which the sale of our single-procedure disposable catheters and guide wires accounted for $97.8 million, or 74.9% of our revenues.

We manufacture our IVUS and FM consoles, IVUS catheters and FM guide wires at our facility in Rancho Cordova, California. We use third-party manufacturing partners to produce circuit boards and mechanical sub-assemblies used in the manufacture of our consoles. We also use third-party manufacturing partners for certain proprietary components used in the manufacture of our single-procedure disposable products. We perform incoming inspection on these circuit boards, mechanical sub-assemblies and components, assemble them into finished products, and test the final product to assure quality control. Our former supplier of FM wire pressure sensors ceased production of this key component on 4" wafers. We secured an end-of-life purchase in 2007 of the subject parts equivalent to an estimated four-year supply. We believe this will provide us with adequate time to initiate and qualify a replacement supplier or a new design to replace the product. We expect that it will take approximately 24 months to identify an appropriate replacement supplier, complete design work and undertake the necessary inspections before the new pressure sensors will be available.

From our inception in January 2000 until July 2003, we were engaged principally in the research and development of tools designed to diagnose vulnerable plaque. In July 2003, we purchased substantially all of the assets and assumed certain liabilities associated with the IVUS and FM product lines of Jomed, Inc. We also acquired certain IVUS patents and technology from Philips in July 2003. These purchases were significant in executing our strategy to leverage our IVUS technology and build our business. Our revenues have increased from $103.0 million in 2006 to $130.6 million in 2007 to $171.5 million in 2008. Our operating loss increased from $6.3 million in 2006 to $33.1 million in 2007, which included a $26.2 million charge related to in-process research and development acquired as part of the acquisition of CardioSpectra, then decreased to $19.7 million in 2008, which included a $12.2 million charge related to in-process research and development acquired as part of the Novelis acquisition. At December 31, 2008, our accumulated deficit was $104.3 million. Since our inception, we have not been profitable for a full fiscal year, and we expect to continue to incur net losses for the foreseeable future.

We completed an underwritten initial public offering on June 15, 2006 in which we sold 7,820,000 shares of our common stock to the public at an offering price of $8.00 per share. The initial public offering resulted in net proceeds of $54.5 million, after deducting offering expenses and underwriting discounts and commissions.

On December 12, 2006, we completed an underwritten follow-on offering in which 3,500,000 shares of our common stock were sold by the Company and 4,000,000 shares were sold by certain selling stockholders, including officers of the company. In addition, we sold 795,000 shares under an over-allotment option exercised by the underwriters. The follow-on offering, including the exercise of the over-allotment option, resulted in net proceeds to the Company of $66.8 million, after deducting offering expenses and underwriting discounts and commissions.

On October 23, 2007, we completed an underwritten follow-on offering in which 8,050,000 shares of our common stock were sold by the Company, including 1,050,000 shares under an over-allotment option exercised by the underwriters. The follow-on offering, including the exercise of the over-allotment option, resulted in net proceeds to the company of $122.8 million, after deducting offering expenses and underwriting discounts and commissions.

During the second half of 2007 and the first quarter of 2008, we pursued an acquisition with an interventional therapy company. Given the other entity's complex legal structure, global revenue base and lack of U.S. GAAP financial statements, the due diligence and deal-related costs were unusually high. We were not able to reach a final definitive agreement and, during the year ended December 31, 2008, we expensed approximately $2.9 million in third-party costs incurred during the due diligence process.

On December 18, 2007, we acquired CardioSpectra, a company founded in 2005 and based in San Antonio, Texas. CardioSpectra's core product line is based on technology licensed from the University of Texas and Dr. Thomas Milner, a co-founder of CardioSpectra. Through CardioSpectra, we are developing innovative OCT technology, which is expected to complement our existing product offerings and further enhance our position as an imaging technology leader in the field of interventional medicine.

On May 15, 2008, we acquired Novelis, a company with proprietary ultrasonic visualization and therapy technology for minimally invasive diagnostic and therapeutic devices. Novelis' proprietary FLIVUS technology platform is expected to build upon our existing suite of products and further enhance our position as an imaging technology leader in the field of interventional medicine by enabling FLIVUS and associated therapies in the interventional cardiology market. We expect to add the Novelis products and capability onto our s5i multi-modality integrated platform/hub.

On December 24, 2008, we acquired Axsun, a company that develops and manufactures optical monitors for telecommunications, lasers and optical engines used in medical OCT imaging systems and advanced photonic components and subsystems used in spectroscopy and other industrial applications. We believe Axsun's

proprietary OCT technology will provide us competitive advantages in the invasive imaging sector. In connection with the Axsun acquisition, we and Axsun were sued by LightLab. LightLab is a wholly owned subsidiary of Goodman, our distributor of IVUS and FM products in Japan, and LightLab develops and sells OCT products for cardiovascular imaging and other medical uses. We believe the complaint is without merit and we intend to opposed the preliminary injunction motion and intend to defend ourselves vigorously.

Financial Operations Overview

The following is a description of the primary components of our revenue and expenses.

Revenues. We derive our revenues primarily from the sale of our IVUS and FM consoles and single-procedure disposables. In 2008, 85.6% of our revenues were derived from the sale of our IVUS consoles and IVUS single-procedure disposables, as compared with 86.0% in 2007 and 85.8% in 2006. In 2008, 73.1% of our revenues were derived from the sale of our IVUS and FM single-procedure disposables, as compared with 74.9% in 2007 and 74.1% in 2006. Other revenues consist primarily of spare parts sales, service and maintenance revenues, shipping and handling revenues and license fees from Medtronic, a related party. Fukuda Denshi accounted for 14.2% of our revenues in 2006. Goodman accounted for 14.4%, 18.0%, and 15.0% of our revenues for the years ended December 31, 2008, 2007 and 2006, respectively.

Our sales in the United States are generated by our direct sales representatives and our products are shipped and billed to hospitals throughout the United States from our facility in Rancho Cordova, California. Our international sales are generated by our direct sales representatives or through independent distributors and are shipped and billed throughout the world from our facilities in Rancho Cordova, California, Zaventem, Belgium and Chiba, Japan.

We experienced a significant increase in our IVUS consoles, IVUS single-procedure disposables and FM single-procedure disposables revenues from 2008 compared with 2007, offset slightly by a decline in our FM consoles business which represents a shift towards our integrated IVUS console product offerings that incorporate the features of our FM consoles.

We expect to experience variability in our quarterly revenues from IVUS and FM consoles due to the timing of hospital capital equipment purchasing decisions, a condition which is inherent in our industry. Further, we expect variability of our revenues based on the timing of our new product introductions which may cause our customers to delay their purchasing decisions until the new products are commercially available. Alternatively, we may include in our arrangements with customers an obligation to deliver new products which are not yet commercially available. In these cases, we would be required to defer associated revenues from these customers until we have met our delivery obligations.

Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we sell and other costs associated with our manufacturing process such as personnel costs, rent and depreciation. In addition, cost of revenues includes royalty expenses for licensed technologies included in our products, service costs, provisions for warranty, distribution, freight and packaging costs and stock compensation expense. We expect our gross margin for IVUS and FM products to improve if we are able to complete our ongoing efforts to streamline and improve our manufacturing processes and increase production volumes. We expect our overall gross margins to decrease due to the acquisition of Axsun and the lower gross margin on their product lines.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel serving the sales, marketing, executive, finance, information technology and human resource functions. Other costs include travel and entertainment expenses, facility costs, trade show, training and other promotional expenses, professional fees for legal and accounting services and stock compensation expense. We expect that our selling, general and administrative expenses will increase as we continue to expand our sales force and marketing efforts and invest in the necessary infrastructure to support our continued growth.

Research and Development. Research and development expenses consist primarily of salaries and related expenses for personnel, consultants, prototype materials, clinical studies, depreciation, regulatory filing fees, certain legal costs related to our intellectual property and stock compensation expense. We expense research and development costs as incurred. We expect our research and development expenses to increase as we continue to develop our products and technologies.

In-process Research and Development. In-process research development, or IPR&D, consists of our projects acquired in connection with acquisitions that had not reached technological feasibility and had no alternative future uses as of each acquisition date.

In December 2007, we acquired the OCT project in connection with our acquisition of CardioSpectra, which was valued at $26.3 million. In-vivo testing and regulatory approval remained to be completed as of the acquisition date at an estimated cost of $7.2 million. In addition, milestone payments of up to $38 million may be paid in connection with successful and timely regulatory approvals and commercialization. The OCT project was expected to be commercialized by late 2008. Our initial assessment of the stage of completion of the OCT project at the acquisition date was underestimated. As of December 31, 2008, the OCT project in-vivo testing had begun and commercialization was behind schedule by approximately two years. In addition, we expect additional costs to complete the OCT project of approximately $12 million. We believe the current schedule is attainable and consistent with deadlines associated with milestone payments. However, if the OCT project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage, experience difficulties in obtaining our forecasted revenues and associated market share and we may not be required to pay some or all of the milestone payments.

In May 2008, we acquired the FLIVUS project in connection with our acquisition of Novelis, which was valued at $12.2 million. In-vivo testing and regulatory approval protocols remained to be completed for the FLIVUS project as of the acquisition date, at an estimated cost of $3.9 million. We expected the FLIVUS project to receive regulatory approvals and be commercialized during 2009. As of December 31, 2008, the project was on schedule. However, if the FLIVUS project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage and experience a potential loss of revenues and associated market share.

In November 2008, we acquired an IPR&D project in connection with our acquisition of Impact Medical Technologies, LLC, a minor acquisition, valued at approximately $300,000.

The following table summarizes our significant IPR&D projects:

                                             Estimated Cost to Complete,
            Project Name     Fair Value        as of acquisition date
            OCT            $ 26.3 million   $                 7.2 million
            FLIVUS           12.2 million                     3.9 million

Amortization of Intangibles. Intangible assets, which consist of our developed technology, licenses, customer relationships, patents and trademarks, are amortized using the straight-line method over their estimated useful lives ranging from three to ten years.

Interest Income. Interest income is comprised of interest income earned from our cash and cash equivalents and our short-term available-for-sale investments.

Interest Expense. Interest expense is comprised primarily of interest expense on capital leases for the years ended December 31, 2008 and 2007. Interest expense is comprised primarily of interest expense on short-term debt and term loans for the year ended December 31, 2006.

Exchange Rate Gain. Exchange rate gain is comprised of foreign currency transaction and remeasurement gains and losses, net.

Provision for Income Taxes. Provision for income taxes is comprised of state, local and foreign income taxes.

We have evaluated our ability to fully utilize the net deferred tax assets on an individual jurisdiction basis. For those jurisdictions in which we believe there is sufficient uncertainty surrounding the realization of deferred tax assets through future taxable income, we have provided a full valuation allowance and no current benefit has been recognized for the net operating loss and other deferred tax assets. Accordingly, deferred tax asset valuation allowances have been established at December 31, 2008, 2007 and 2006 to reflect these uncertainties. The federal net operating loss carryforwards begin to expire in 2020, the state net operating loss carryforwards begin to expire in 2012 and the foreign net operating loss carryforwards begin to expire in 2009, unless these net operating losses are previously utilized. We also have federal research and experimentation tax credits, which begin to expire in 2022, and state research and experimentation tax credits, which carry forward indefinitely.

Results of Operations

The following table sets forth items derived from our consolidated statements of operations for the years ended December 31, 2008, 2007 and 2006 presented in both absolute dollars (in thousands) and as a percentage of revenues:

                                                             Years Ended December 31,
                                            2008                       2007                       2006
Revenues                            $ 171,495      100.0 %     $ 130,614      100.0 %     $ 103,048      100.0 %
Cost of revenues                       64,293       37.5          51,559       39.5          41,715       40.5

Gross profit                          107,202       62.5          79,055       60.5          61,333       59.5
Operating expenses:
Selling, general and
administrative                         84,369       49.2          62,631       48.0          47,614       46.2
Research and development               26,690       15.6          20,315       15.6          16,923       16.4
In-process research and
development                            12,681        7.4          26,188       20.0              -          -
Amortization of intangibles             3,125        1.8           3,067        2.3           3,117        3.0

Total operating expenses              126,865       74.0         112,201       85.9          67,654       65.6

Operating loss                        (19,663 )    (11.5 )       (33,146 )    (25.4 )        (6,321 )     (6.1 )
Interest income                         4,828        2.8           5,841        4.5             958        0.9
Interest expense                         (113 )     (0.1 )          (199 )     (0.2 )        (4,013 )     (3.9 )
Exchange rate gain                      1,809        1.1           1,452        1.1           1,053        1.0
Other, net                                 54        0.1              -          -               18        0.0

Loss before provision for income
taxes                                 (13,085 )     (7.6 )       (26,052 )    (19.9 )        (8,305 )     (8.1 )
Provision for income taxes                620        0.4             524        0.4             298        0.3

Net loss                            $ (13,705 )     (8.0 )%    $ (26,576 )    (20.3 )%    $  (8,603 )     (8.3 )%

The following table sets forth our revenues by geography expressed as dollar amounts (in thousands) and the changes in revenues between the specified periods expressed as percentages:

                                             Years Ended December 31,                   Percentage Change
                                         2008          2007          2006        2007 to 2008       2006 to 2007
Revenues (1):
United States                          $  87,513     $  66,411     $  51,013             31.8 %             30.2 %
Japan                                     43,582        35,186        30,082             23.9 %             17.0 %
Europe, the Middle East and Africa        33,197        23,995        17,765             38.4 %             35.1 %
Rest of world                              7,203         5,022         4,188             43.4 %             19.9 %

                                       $ 171,495     $ 130,614     $ 103,048             31.3 %             26.8 %

(1) Revenues are attributed to geographies based on location of the customer, except for original equipment manufacturer revenues which are attributed to the geography of the legal entity invoicing.

The following table sets forth our revenues by product expressed as dollar amounts (in thousands) and the changes in revenues between the specified periods expressed as percentages:

                                        Years Ended December 31,                   Percentage Change
                                    2008          2007          2006        2007 to 2008        2006 to 2007
IVUS:
Consoles                          $  38,788     $  26,847     $  22,128             44.5 %              21.3 %
Single-procedure disposables        107,963        85,538        66,268             26.2 %              29.1 %
FM:
Consoles                              1,280         2,064         1,954            (38.0 )%              5.7 %
Single-procedure disposables         17,388        12,260        10,072             41.8 %              21.7 %
Other                                 6,076         3,905         2,626             55.6 %              48.7 %

                                  $ 171,495     $ 130,614     $ 103,048             31.3 %              26.8 %

Comparison of Years Ended December 31, 2008 and 2007

Revenues. Revenues increased $40.9 million, or 31.3%, to $171.5 million in the year ended December 31, 2008, as compared to revenues of $130.6 million in the year ended December 31, 2007. In the year ended December 31, 2008, IVUS revenues increased $34.4 million, or 30.6%, as compared to the year ended December 31, 2007, which is comprised of an increase of $22.4 million, or 26.2%, from sales of our single-procedure disposable IVUS products and an increase of $11.9 million, or 44.5% in sales of our IVUS consoles. In the year ended December 31, 2008, FM revenues increased $4.3 million, or 30.3%, as compared to the year ended December 31, 2007, which is comprised of an increase of $5.1 million, or 41.8%, in sales of our single-procedure disposable FM products, . . .